Netflix Faces Rising Costs

Netflix Inc.
NFLX -1.03%
posted an 86% jump in quarterly profits as its online movie streaming service clicked with consumers, but the company forecast rising costs for licensing content that will eat into earnings.

Netflix also announced it will pass a milestone during its current quarter, when for the first time it will mail out fewer rental DVDs in its distinctive red envelopes than it did in the same period the prior year. The decline in DVD shipments underscores the speed of the transition Netflix is making to streaming Internet video from mailing physical copies of movies to its members.

The appeal of Netflix's streaming service has fueled its growth in subscribers, which jumped 69% to 23.6 million during the first quarter from just under 14 million a year ago.

Yet the decline of the DVD rental business, ironically, may not be happening swiftly enough. Executives of the Los Gatos, Calif., company have said in the past that they expect to offset the growing costs of licensing television shows and movies for its streaming services from entertainment companies with reduced postage costs as members stream more videos and rent fewer DVDs.

Movie-rental company Netflix delivered an 88% pop in quarterly profit, but investors keyed in on the company's future, which could reflect the rising costs of striking content deals with movie companies.

Netflix forecast earnings for the second quarter ending June 30 that were weaker than Wall Street analysts anticipated. The company said it expects to report earnings per share for the second quarter between 93 cents and $1.15, compared to the $1.18 expected on average by analysts surveyed by Thomson Reuters.

"The signal is streaming content costs are rising faster than we thought and that means earnings growth is slower than we thought," said
Michael Pachter,
an analyst at Wedbush Morgan Securities.

In after hours trading Monday, Netflix stock fell 5% to $239.21, after closing at 4 p.m. at $251.67.

Netflix doesn't say explicitly how much it spends to license content for its streaming service, but the company said in a letter to shareholders that it expects those costs to "increase substantially" in the second quarter and beyond. Mr. Pachter estimates Netflix's streaming costs next year will jump to between $1.6 billion and $2.2 billion from $700 million this year.

Still, Netflix's growth in the first quarter showed why the company has emerged as an entertainment powerhouse, at a time when other traditional distributors of video, like
Time Warner Inc.'s
TWX -0.65%
HBO, are struggling to hold on to subscribers.

For the quarter ended March 31, Netflix reported an increase in net income to $60.2 million, or $1.11 a share, from $32.3 million, or 59 cents a share, during the same period a year earlier. Revenue rose 46% from a year earlier to $719 million.

One of the efforts Netflix is making to enhance the appeal of its streaming service is an agreement for an upcoming miniseries from director
David Fincher
called "House of Cards" that will air first on Netflix. In its letter to shareholders, Netflix said the undisclosed costs from that series won't affect its results until late 2012, when the show premiers.

In the letter to shareholders, signed by Netflix Chief Executive
Reed Hastings
and Chief Financial Officer
David Wells,
the company said it hopes to make two or three similar deals for original series so it can "gain confidence that whatever results we achieve are repeatable."

The two executives said in the letter that its DVD offerings will be a "fading differentiator" for the service, which last year began letting people subscribe to a streaming only service for $7.99. Already the company has begun to discourage people from choosing rental plans that offer consumers the option of also renting DVDs. In its letter to shareholders, the company said the sign-up page on its website for non-members is now "all about streaming."